UNIT – 2

Meaning of Demand
Demand is a common parlance means desire for an object. But in economics demand is something more than
this. In economics “Demand” means the quantity of goods and services which a person can purchase with a
requisite amount of money.

According to Prof. Hidbon, Demand means the various quantities of goods that would be purchased per time
period at different prices in a given market. Thus demand for a commodity is its quantity which consumer is able
and willing to buy at various prices during a given period of time. Simply, demand is the behavior of potential
buyers in a market.

In the opinion of Stonier and Hague, “Demand in economics means demand backed up by enough money to pay
for the goods demanded”. In other words, demand means the desire backed by the willingness to buy a commodity
and purchasing power to pay. Hence desire alone is not enough. There must have necessary purchasing power,
ie, .cash to purchase it. For example, everyone desires to posses Benz car but only few have the ability to buy it.
So everybody cannot be said to have a demand for the car. Thus the demand has three essentials-Desire,
Purchasing power and Willingness to purchase.

Importance of Demand
Determinants of Demand

Demand is fluctuating time to time. There are majorly six factors which affect the demand for a commodity
(Product).

Determinants of Demand Mean

1. Consumer preferences: personality characteristics, occupation, age, advertising, and product quality, all
are key factors affecting consumer behavior and, therefore, demand.

2. Prices of related products: an increase in the price of one product will cause a decrease in the quantity
demanded of a complementary product. In contrast, an increase in the price of one product will cause an
increase in the demand for a substitute product.

3. Consumer income: the higher the consumer income, the higher the demand and vice versa.

4. Consumer expectations: expectations for a higher income or higher prices increase the quantity
demanded. Expectations for a lower income or lower prices decrease the quantity demanded.

5. The number of buyers: the higher the number of buyers, the higher the quantity demanded, and vice
versa.

6. Other factors: the weather and governmental policies that may expand or contract the economy affect
the demand for particular products or services.
Substitution Effect
Law of Demand

The law of demand is one of the most fundamental concepts in economics. It works with the law of supply to
explain how market economies allocate resources and determine the prices of goods and services that we observe
in everyday transactions. The law of demand states that quantity purchased varies inversely with price. In
other words, the higher the price, the lower the quantity demanded. This occurs because of diminishing
marginal utility. That is, consumers use the first units of an economic good they purchase to serve their most
urgent needs first, and use each additional unit of the good to serve successively lower valued ends.

• The law of demand is a fundamental principle of economics which states that at higher price consumers
will demand a lower quantity of a good.
• Demand is derived from the law of diminishing marginal utility, the fact that consumers use economic
goods to satisfy their most urgent needs first.
• A market demand curve expresses the sum of quantity demanded at each price across all consumers in
the market.
• Changes in price can be reflected in movement along a demand curve, but do not by themselves increase
or decrease demand.
• The shape and magnitude of demand shifts in response to changes in consumer preferences, incomes, or
related economic goods, NOT to changes in price.

Exceptions to the Law of Demand

Note that the law of demand holds true in most cases. The price keeps fluctuating until equilibrium is created.
However, there are some exceptions to the law of demand. These include the Giffen goods, Veblen goods,
possible price changes, and essential goods. Let us discuss these exceptions in detail.

Giffen Goods

Giffen Goods is a concept that was introduced by Sir Robert Giffen. These goods are goods that are inferior in
comparison to luxury goods. However, the unique characteristic of Giffen goods is that as its price increases, the
demand also increases. And this feature is what makes it an exception to the law of demand.

The Irish Potato Famine is a classic example of the Giffen goods concept. Potato is a staple in the Irish diet.
During the potato famine, when the price of potatoes increased, people spent less on luxury foods such as meat
and bought more potatoes to stick to their diet. So as the price of potatoes increased, so did the demand, which is
a complete reversal of the law of demand.

Veblen Goods

The second exception to the law of demand is the concept of Veblen goods. Veblen Goods is a concept that is
named after the economist Thorstein Veblen, who introduced the theory of “conspicuous consumption”.
According to Veblen, there are certain goods that become more valuable as their price increases. If a product is
expensive, then its value and utility are perceived to be more, and hence the demand for that product increases.

And this happens mostly with precious metals and stones such as gold and diamonds and luxury cars such as
Rolls-Royce. As the price of these goods increases, their demand also increases because these products then
become a status symbol.

The expectation of Price Change

In addition to Giffen and Veblen goods, another exception to the law of demand is the expectation of price change.
There are times when the price of a product increases and market conditions are such that the product may get
more expensive. In such cases, consumers may buy more of these products before the price increases any further.
Consequently, when the price drops or may be expected to drop further, consumers might postpone the purchase
to avail the benefits of a lower price.

For instance, in recent times, the price of onions had increased to quite an extent. Consumers started buying and
storing more onions fearing further price rise, which resulted in increased demand.

There are also times when consumers may buy and store commodities due to a fear of shortage. Therefore, even
if the price of a product increases, its associated demand may also increase as the product may be taken off the
shelf or it might cease to exist in the market.

Necessary Goods and Services

Another exception to the law of demand is necessary or basic goods. People will continue to buy necessities such
as medicines or basic staples such as sugar or salt even if the price increases. The prices of these products do not
affect their associated demand.

Change in Income

Sometimes the demand for a product may change according to the change in income. If a household’s income
increases, they may purchase more products irrespective of the increase in their price, thereby increasing the
demand for the product. Similarly, they might postpone buying a product even if its price reduces if their income
has reduced. Hence, change in a consumer’s income pattern may also be an exception to the law of demand.

Concept of Measurement of Elasticity of Demand

A change in the price of a commodity affects its demand. We can find the elasticity of demand, or the degree of
responsiveness of demand by comparing the percentage price changes with the quantities demanded. In this
article, we will look at the concept of elasticity of demand and take a quick look at its various types.

Elasticity of Demand

To begin with, let’s look at the definition of the elasticity of demand: “Elasticity of demand is the responsiveness
of the quantity demanded of a commodity to changes in one of the variables on which demand depends. In other
words, it is the percentage change in quantity demanded divided by the percentage in one of the variables on
which demand depends.”
The following points highlight the top five methods used for measuring the elasticity of demand. The methods
are:

1. Price Elasticity of Demand

2. Income Elasticity of Demand
3. Cross Elasticity of Demand
4. Advertisement or Promotional Elasticity of Sales
5. Elasticity of Price Expectations.

Method # 1. Price Elasticity of Demand

Price elasticity of demand is a measure of the responsiveness of demand to changes in the commodity’s own
price. It is the ratio of the relative change in a dependent variable (quantity demanded) to the relative change in
an independent variable (Price). In other words, price elasticity is the ratio of a relative change in quantity
demanded to a relative change in price.

Also, elasticity is the percentage change in quantity demanded divided by the percentage in price.

Symbolically, we may rewrite the formula:

If percentages are known, the numerical value of elasticity can be calculated. The coefficient of elasticity of
demand is a pure number i.e. it stands by itself, being independent of units of measurement. The coefficient of
price elasticity of demand can be calculated with the help of the following formula.

Where,

Q is quantity, P is price, ΔQ/Q relative change in the quantity demanded and ΔP/P Relative change in price.

It should be noted that a minus sign (-) is generally inserted in the formula before the fraction with a view to
making the coefficient of elasticity a non-negative value.

The price elasticity can be measured between two finite points on a demand curve (called arc elasticity) or on a
point (called point elasticity).

Method # 2. Income Elasticity of Demand

The responsiveness of quantity demanded to changes in income is called income elasticity of demand. With
income elasticity, consumer incomes vary while tastes, the commodity’s own price, and the other prices are held
constant.

The income elasticity of demand for a good or service may be calculated by the formula:
where- ey stands for the coefficient of income elasticity, Y for income.

Whereas price-elasticity of demand is always negative, income-elasticity of demand is always positive (except
for inferior goods) as the relationship between income and quantity demanded of a product is positive. For inferior
goods the income elasticity of demand is negative because as income increases, consumers switch over to the
consumption of superior substitutes.

Method # 3. Cross Elasticity of Demand

Demand is also influenced by prices of other goods and services. The cross elasticity measures the responsiveness
of quantity demanded to changes in price of other goods and services. Cross elasticity of demand is defined as
the percentage change in quantity demanded of one good caused by a 1 percentage change in the price of some
other good.

Cross elasticity is used to classify the relationship between goods. If cross elasticity is greater than zero, an
increase in the price of y causes an increase in the quantity demanded of x, and the two products are said to be
substitutes. When the cross- elasticity is greater than zero, the goods or services involved are classified as
complements Increases in the price of y reduces the quantity demanded of that product. Diminished demand for
y causes a reduced demand for x. Bread and butter, cars and tires, and computers and computer programs are
examples of pairs of goods that are complements.

The coefficient is positive if A and B are substitutes because the price change and the quantity change are in the
same direction. The coefficient is negative if A and B are complements, because changes in the price of one
commodity cause opposite changes in the quantity demanded of the other. Other things such as consumer taste
for both commodities, consumer incomes and the price of the other commodity are held constant.

Method # 4. Advertisement or Promotional Elasticity of Sales

The advertisement expenditure helps in promoting sales. The impact of advertisement on sales is not uniform at
all level of total sales. The concept of advertising elasticity is significant in determining the optimum level of
advertisement outlay particularly in view of competitive advertising by rival firms. An advertising elasticity could
be defined as the percentage change in quantity demanded for a percentage change in advertising. Advertising
might be measured by expenditure.

Advertising elasticity may be measured by the following formula:

Method # 5. Elasticity of Price Expectations

People’s price expectations also play a significant role as a determinant of demand. J.R. Hicks, the English
economist, in 1939, devised the concept of elasticity of price expectations. The elasticity of price expectations
may be defined as the ratio of the relative change in expected future prices to the relative change in current prices.

Uses of Elasticity of Demand for Managerial Decision Making

The concept of price elasticity of demand has important practical applications in managerial decision-making. A
business man has often to consider whether a lowering of price will lead to an increase in the demand for his
product, and if so, to what extent and whether his profits would increase as a result thereof. Here the concept of
elasticity of demand becomes crucial.

Knowledge of the nature of the elasticity of demand for his products will help a business to decide whether he
should cut his price in a particular case. Such knowledge would also help a businessman to determine whether
and to what extent the increase in costs could be passed on to the consumer. In general for items those whose
demand is elastic it will pay him to charge relatively low prices, while on those whose demand is elastic, it would
be better off with a higher price. A monopolist would not be able to increase his price if the demand for his
product is elastic.

In practice, an accurate estimate of the probable response of volume of sales to price changes is extremely
difficult. Moreover, the cost of the statistical analysis required may in some cases, exceed the benefit especially
when uncertainty is great or when the volume is too small to provide a reason also return on the amount spend
on research. The subjective judgment of certain managers, beyond on years of experience, sometimes exceeds in
accuracy the best of the present statistical techniques. Uses of price elasticity can be point out as below:

1. Price Distribution

A monopolist adopts a price discrimination policy only when the elasticity of demand of different consumers or
sub-markets is different. Consumers whose demand is inelastic can be charged a higher price than those with
more elastic demand.

2. Public utility pricing

In case of public utilities which are run as monopoly undertakings e.g. elasticity of water supply railways postal
services, price discrimination is generally practiced, charging higher prices from consumers or users with inelastic
demand and lower prices in case of elastic demand.

3. Joint Supply

Certain goods, being products of the same process are jointly supplied, e.g. wool and mutton. Here if the demand
for wool is inelastic compared to the demand for mutton, a higher price for wool can be charged with advantage.

4. Super Markets

Super-markets are a combined set of shops run by a single organization selling a wide range of goods. They are
supposed to sell commodities at lower prices than charged by shopkeepers in the bazaar. Hence, price policy
adopted is to charge slightly lower price for goods with elastic demand.
 5. Use of Machine

Workers often oppose use of machines out of fear of unemployment. Machines need not always reduce demand
for labor as this depends on price elasticity of demand for the commodity produced. When machines reduce costs
and hence price of products, if the products demand is elastic, the demand will go up, production will have to be
increased and more workers may be employed for the product is inelastic, machines will lead to unemployment
as lower prices will not increase the demand.

6. Factor Pricing

The factors having price inelastic demand can obtain a higher price than those with elastic demand. Workers
producing products having inelastic demand can easily get their wages raised.

7. International Trade

(a) A country benefits from exports of products as have price inelastic demand for a rise in price and elastic
demand for a fall in price. (b) The demand for imports should be inelastic for a fall in price and elastic for a rise
in price. (c) While deciding whether to devalue a country’s currency or not, price elasticity of demand for a
country’s exports would be an important factor to be taken into consideration. If the demand is price elastic, it
would lead to an increase in the country’s exports and devaluation would fail to achieve its objective.

8. Shifting of Tax Burden

It is possible for a business to shift a commodity tax in case of inelastic demand to his customers. But if the
demand is elastic, he will have to bear the tax burden himself, otherwise demand for his goods will go down
sharply.

9. Taxation Policy

Government can easily raise tax revenue by taxing commodities which are price inelastic.

Demand Forecasting: Need, Objectives and Methods

Some of the popular definitions of demand forecasting are as follows:

According to Evan J. Douglas, “Demand estimation (forecasting) may be defined as a process of finding values
for demand in future time periods.”

In the words of Cundiff and Still, “Demand forecasting is an estimate of sales during a specified future period
based on proposed marketing plan and a set of particular uncontrollable and competitive forces.”

Demand forecasting enables an organization to take various business decisions, such as planning the production
process, purchasing raw materials, managing funds, and deciding the price of the product. An organization can
forecast demand by making own estimates called guess estimate or taking the help of specialized consultants or
market research agencies.

Need of Demand Forecasting

Demand plays a crucial role in the management of every business. It helps an organization to reduce risks
involved in business activities and make important business decisions. Apart from this, demand forecasting
provides an insight into the organization’s capital investment and expansion decisions.

(i) Fulfilling objectives

Implies that every business unit starts with certain pre-decided objectives. Demand forecasting helps in fulfilling
these objectives. An organization estimates the current demand for its products and services in the market and
move forward to achieve the set goals.

For example, an organization has set a target of selling 50, 000 units of its products. In such a case, the
organization would perform demand forecasting for its products. If the demand for the organization’s products is
low, the organization would take corrective actions, so that the set objective can be achieved.

(ii) Preparing the budget

Plays a crucial role in making budget by estimating costs and expected revenues. For instance, an organization
has forecasted that the demand for its product, which is priced at Rs. 10, would be 10, 00, 00 units. In such a case,
the total expected revenue would be 10* 100000 = Rs. 10, 00, 000. In this way, demand forecasting enables
organizations to prepare their budget.

(iii) Stabilizing employment and production

Helps an organization to control its production and recruitment activities. Producing according to the forecasted
demand of products helps in avoiding the wastage of the resources of an organization. This further helps an
organization to hire human resource according to requirement. For example, if an organization expects a rise in
the demand for its products, it may opt for extra labor to fulfill the increased demand.

(iv) Expanding organizations

Implies that demand forecasting helps in deciding about the expansion of the business of the organization. If the
expected demand for products is higher, then the organization may plan to expand further. On the other hand, if
the demand for products is expected to fall, the organization may cut down the investment in the business.

(v) Taking Management Decisions

Helps in making critical decisions, such as deciding the plant capacity, determining the requirement of raw
material, and ensuring the availability of labor and capital.

(vi) Evaluating Performance

Helps in making corrections. For example, if the demand for an organization’s products is less, it may take
corrective actions and improve the level of demand by enhancing the quality of its products or spending more on
advertisements.

(vii) Helping Government

Enables the government to coordinate import and export activities and plan international trade.

Objectives of short-term demand forecasting :

1. Production policy: Short-term demand forecasting is used to evolve a suitable production policy which
can avoid the problems of over production and short supply.
2. Expenditure pattern: It helps the firm in purchasing. Knowledge of near future economic conditions
help the firm in reducing costs of purchasing raw materials and controlling inventory.
3. Sales policy: Demand forecasting helps the firm in evolving a suitable sales policy.
4. Price policy: Sales forecasting is useful in determining pricing policy. When the market conditions are
expected to be weak, the firm can avoid an increase in price and vice-versa.
5. Sales targets, controls and incentives: Short term demand forecasting is used to set sales targets and for
establishing controls and incentives.
 6. Financial requirements: It is useful in forecasting short term financial requirements. Cash requirement
depends on production and sales levels. Hence sales forecasts help the firm to make arrangements for
necessary funds well in advance.

Objectives of long term demand forecasting :

1. New unit or expansion: Long term demand forecasting helps in planning of a new unit or expansion of
an existing unit of a business organization.
2. Financial requirements: It is useful in long term financial planning. Long-term sales forecast is
necessary to estimate long term financial requirements.
3. Man power planning: Long term demand forecasting enables the firm to make arrangements for training
and personnel development. Demand forecasting is also useful to the Government in determining import
and export policies.

Objectives Of Demand Forecasting In Business Economics is well recognized by the business organizations who
want to produce goods at optimum level. The objectives of short-term demand forecasting are different from
those of long term demand forecasting.

Methods of Demand Forecasting

There is no easy or simple formula to forecast the demand. Proper judgment along with the scientific formula is
needed to correctly predict the future demand for a product or service. Some methods of demand forecasting are
discussed below:

1. Survey of Buyer’s Choice

When the demand needs to be forecasted in the short run, say a year, then the most feasible method is to ask the
customers directly that what are they intending to buy in the forthcoming time period. Thus, under this method,
the potential customers are directly interviewed. This survey can be done in any of the following ways:

• Complete Enumeration Method: Under this method, nearly all the potential buyers are asked about their
future purchase plans.
• Sample Survey Method: Under this method, a sample of potential buyers is chosen scientifically and only
those chosen are interviewed.
• End-use Method: It is especially used for forecasting the demand of the inputs. Under this method, the
final users i.e. the consuming industries and other sectors are identified. The desirable norms of
consumption of the product are fixed, the targeted output levels are estimated and these norms are applied
to forecast the future demand of the inputs.

Hence, it can be said that under this method the burden of demand forecasting is on the buyer. However, the
judgments of the buyers are not completely reliable and so the seller should take decisions in the light of his
judgment also.

The customer may misjudge their demands and may also change their decisions in the future which in turn may
mislead the survey. This method is suitable when goods are supplied in bulk to industries but not in the case of
household customers.

2. Collective Opinion Method

Under this method, the salesperson of a firm predicts the estimated future sales in their region. The individual
estimates are aggregated to calculate the total estimated future sales. These estimates are reviewed in the light of
factors like future changes in the selling price, product designs, changes in competition, advertisement campaigns,
the purchasing power of the consumers, employment opportunities, population, etc.
The principle underlying this method is that as the salesmen are closest to the consumers they are more likely to
understand the changes in their needs and demands. They can also easily find out the reasons behind the change
in their tastes.

Therefore, a firm having good sales personnel can utilize their experience to predict the demands. Hence, this
method is also known as Salesforce opinion or Grassroots approach method. However, this method depends on
the personal opinions of the sales personnel and is not purely scientific.

3. Barometric Method

This method is based on the past demands of the product and tries to project the past into the future. The economic
indicators are used to predict the future trends of the business. Based on the future trends, the demand for the
product is forecasted. An index of economic indicators is formed. There are three types of economic indicators,
viz. leading indicators, lagging indicators, and coincidental indicators.

The leading indicators are those that move up or down ahead of some other series. The lagging indicators are
those that follow a change after some time lag. The coincidental indicators are those that move up and down
simultaneously with the level of economic activities.

4. Market Experiment Method

Another one of the methods of demand forecasting is the market experiment method. Under this method, the
demand is forecasted by conducting market studies and experiments on consumer behavior under actual but
controlled, market conditions.

Certain determinants of demand that can be varied are changed and the experiments are done keeping other factors
constant. However, this method is very expensive and time-consuming.

5. Expert Opinion Method

Usually, the market experts have explicit knowledge about the factors affecting the demand. Their opinion can
help in demand forecasting. The Delphi technique, developed by Olaf Helmer is one such method.

Under this method, experts are given a series of carefully designed questionnaires and are asked to forecast the
demand. They are also required to give the suitable reasons. The opinions are shared with the experts to arrive at
a conclusion. This is a fast and cheap technique.

6. Statistical Methods

The statistical method is one of the important methods of demand forecasting. Statistical methods are scientific,
reliable and free from biases. The major statistical methods used for demand forecasting are:

• Trend Projection Method: This method is useful where the organization has sufficient amount of
accumulated past data of the sales. This date is arranged chronologically to obtain a time series. Thus, the
time series depicts the past trend and on the basis of it, the future market trend can be predicted. It is
assumed that the past trend will continue in future. Thus, on the basis of the predicted future trend, the
demand for a product or service is forecasted.
• Regression Analysis: This method establishes a relationship between the dependent variable and the
independent variables. In our case, the quantity demanded is the dependent variable and income, the price
of goods, price of related goods, the price of substitute goods, etc. are independent variables. The
regression equation is derived assuming the relationship to be linear. Regression Equation: Y = a + bX.
Where Y is the forecasted demand for a product or service.